Start Investing by Building an Emergency Fund

S4F Emergency Fund @ Savings4Freedom
Common sense investing starts by building an emergency fund. It brings you true peace of mind to navigate stressful situations. How big? Where? You decide!

Among my personal financial heroes, John C. Bogle, founder of the Vanguard Group and creator of the index mutual fund, is among the champions with the biggest impact on individual investors results in history. He died at the beginning of 2019, but his lessons for investing are simple elegance, and deeply valuable for any type of investor. One aspect that should be common sense is that if you want to start investing, building an emergency fund should be your first step.

“Simplicity is the master key to financial success. When there are multiple solutions to a problem, choose the simplest one.”

Investing with Simplicity, John Bogle

Investing your money requires as much common sense as knowledge about the various asset classes, how they work and how to best invest in them. You need to define clear goals with appropriate time allocations. You need to know the reason why you want to start investing. Take the time to define your personal goals and keep in mind that your investment objectives should be measurable and attainable based on your current personal/family budget. Your success cannot depend upon outsize investment returns, nor upon impractical savings or spending habits.

Start Investing the Right Way

A common sense investment strategy starts with a clear assessment of your financial reality:

  • Make a full analysis on your personal/family budget. Include your income, costs and bills, lifestyle, and savings. Ensure you have a clear and real picture of what your financial life looks like. With this knowledge, you are now ready to start investing? Not yet!
  • In case you have outstanding debts, with high interest costs, make sure you pay them before allocating resources to investments. Take special attention to any personal loans that represent a liability on your personal finances.
  • Now it’s time to start your emergency fund. Investing with common sense requires the creation of an emergency fund capable of providing all mandatory living expenses for a period of at least 6 months. These funds should be kept in a liquid instrument that you can use in case of emergencies. Emergencies can come in the form of job losses or sudden health issues. You need to be prepared with cash for everyday living expenses like rent, groceries or medicines without the need to trade your investment portfolio.

The Importance of having an Emergency Fund

Although it may seem like a sacrifice, specially now with low interest rates, setting aside money in an emergency fund provides you with true peace of mind and helps you to navigate stressful situations. It makes you free to identify and take care of the problem without the additional immediate concern about financial sustainability.

Having a emergency fund is also a way to protect your investments. For example, if you’re invested in the stock market and need funds for a medical emergency, you will not need to sell your position untimely to cover the costs. Instead, you’ll use your emergency fund for that. Having an emergency fund helps you to keep the plan you defined for your investments even when you face the unexpected.

How to Build an Emergency Fund

Use common sense once more… save first!

The first trick to savings is not to wait and see how much you “have left over” at the end of the month, but rather to “pay yourself first.” At the beginning of the month (or each time you get paid), put aside a certain amount towards your emergency savings before you do anything else.

If you don’t have budget to invest because you allocated resources for your emergency fund, you took the right decision. Make sure to build your emergency fund savings piece by piece until you reach your personal goals: 1 month expenses? 6 months expenses? 12 months expenses? You decide!

Where to put your Emergency Fund?

Common sense tells you the answer… high yield guaranteed savings accounts or short term treasury bills. Always look for solutions that allow you almost instant access to the money when you need it.

It often makes sense to keep your emergency fund at a bank separate from your main bank accounts. That way you won’t be tempted to dip into your emergency fund for everyday expenses. Or divide your emergency fund into smaller components that you distribute across savings accounts, short term treasury bills to maximize the small return and look for options that yield values close to the inflation value.

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You can’t know the future, but you need to define your plan and stick to it! Remember that the enemy of a good plan is the search for a perfect plan. Make assumptions, and then change them when you get better ideas or better information. Putting your personal plan in writing will help you maintain the necessary discipline to “stay the course”, but before anything… build your emergency fund!

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